Saturday, February 2, 2008

Psychology 101

One of those neverending debates among newer traders... role of psychology in trading. Some claim it's all there is to trading. Some argue it's nothing but red herring, and one just needs to follow his signals (system, indicators, whatever) and no psychobabble will ever be needed. Yet some say psychology is important and assign some weight to it - "80% of trading is psychology"... or 95%... Not sure how they measure it, I personally like 76.364%.

Two things to say about this.

First, we are different. Some simply cannot change their behavior and no matter what system they are given they just can't follow it. Their personality takes over pushing them into all kinds of trading no-nos. Then there are others who don't seem to experience any impact of their inner workings, they see the light and follow it. Obviously, the role of psychology will be drastically different for those two types.

Second, and most significant for most of us. We go through different stages in our learning curve. As far as trading psychology is concerned, I can clearly see three stages that are most common among traders.

First stage is total ignoring or underappreciation of this aspect of trading. By ignorance, by arrogance or for whatever else reason, a trader doesn't give it much thoughts while focusing on technical side of trading.

Second stage is acknowledgment. Running into troubles with their inner gear, reading books or listening to others, traders become aware of the ways their personality interferes with their trading. They have met the enemy.

Finally, third stage is dismissal of psychology again. Maybe dismissal is not the right word but that's how it feels for it's no longer needed. At this stage it becomes unneeded as a trader overcomes his inner barriers, changes himself, learns to behave in a right way and this correct behavior becomes second nature. Just as learning to swim you stop thinking of how to move when swimming, in the same way you stop giving time and thoughts to psychology of your trading again - seemingly returning to a first stage, although it's obviously another level you reach. You simply mastered it and stopped thinking about it.

It's important to understand that this third stage exists and make it your target to achieve it. Too many traders simply get stuck at the second stage - they think of it all the time, they make it their point of focus to such degree aand for so long that they just can't seem to get out of it. Development stops, they become locked in this endless inner digging. No need to rush through this second stage but to get stuck in it forever is no fun either.

In the following posts I intend to discuss each of those three stages a bit deeper. And, if you are lucky to belong to that second type, ignore this part of blog altogether. Check out the fourth stage though which discusses the highest craftsmanship of this side of trading.
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